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Financial sector suffers worst day in 11 years as COVID-19 outbreak raises risk of recession

The financial sector took a deep dive Monday, as the Federal Reserve cut interest rates on Sunday to around 0%, at the same time the biggest banks announced a suspension of buybacks, which served as a one-two punch for the group's earnings outlook.

The growing risk of a global recession resulting from the COVID-19 pandemic leading to weaker demand and credit metrics on loans is adding to the negative view for the sector.

"We have changed the outlook on the U.S. banking system to 'negative' from 'stable' to reflect the growing strain on banks' operating environment and asset risk from the ongoing coronavirus' disruption of economic and business activity," said Moody's Senior Vice President Joseph Pucella.

The SPDR Financial Select Sector exchange-traded fund(XLF) plummeted 13.7% to a 3 1/2-year low of $19.89, with all 66 equity components trading lower. That was the biggest one-day percentage drop since it fell 16.5% on Jan. 20, 2009, in the midst of the financial crisis.

The selloff comes after the Federal Reserve announced on Sunday that it was cutting its target of the benchmark federal-funds rate by a full percentage point, to a range o 0% to 0.25%. That cut comes less than two weeks after the Fed cut rates by 50 basis points.

Analyst David Long at Raymond James said the "immediate implication" of the rate cut is to lower the lending rate on variable-rate loans, particularly commercial and industrial (C&I) loans, which are indexed to London interbank offered rates (Libor) and the Prime rate. Long said other areas to be hurt by the rate cuts include returns on short-term assets, such as money-market and other cash-like securities, and certain commercial real estate, consumer and specialty-finance loans.

"This rate cut will be negative to nearly all bank [earnings per share], particularly the speed for which rates contracted over the last few weeks," Long wrote in a note to clients. "Both the Street forecasts and our estimates do not bake in such a scenario."

J.P. Morgan's Vivek Juneja said he estimates the suspension of buybacks to lower EPS for the group by an average of 1.1% in 2020, and by an average of 1.6% in 2021.

Individually, he said 2020 earnings for BofA would be reduced by 1.5%, for Citi would be lowered by 1.4% and for Wells Fargo would be shaved by 1.1%.

Those reductions are on top of the negative 6% to 19% impact on EPS from zero rates.

What could also hurt earnings, Juneja said, is that loan growth is running below expectations in the first quarter, while deposit liability growth has surged.

For Oppenheimer's Chris Kotowski, "share buybacks have been a key component of our investment case, and the complete suspension is an obvious negative." He added, however, that as the banks he follows are likely to remain profitable, they'll likely grow capital that can be used for buyback at some later date.

If there is a positive, Raymond James's Long said that the lower deposit rates, particularly for time deposits will help offset the lower returns from loans, while Moody's Pucella said the Fed's bond-buying program announced Sunday should help improve the banks' already strong liquidity.

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